Buying dividend-paying stocks or dividend stock funds is a great way to obtain passive income from a stock portfolio. A portfolio consisting of dividend-paying stocks can compound significantly over many years. This article will outline how to add dividend-paying stocks to your portfolio, and further outline the benefits and risks of dividend-paying stocks and funds.
How to Buy Dividend Stocks
Buying a stock that pays a dividend is as simple as buying any other stock. The investor opens an account at a brokerage firm, researches the dividend-paying stock or fund they want to purchase, then purchases the stock or fund through the broker’s order entry system.
Steps Required to Buy Dividend Stocks
Buying dividend stocks is a relatively straightforward process. The investor opens and funds an account, researches the stock or fund they want to purchase, makes the purchase, and then monitors their position.
Here’s how it works.
Step 1: Open a brokerage account. Opening an account is a very easy process and can be done online. Accounts can be opened quickly, and do not require funding immediately. Dividend investing is not as intense as swing or other more active trading styles, so most online brokers are suitable for this more passive investment strategy that usually entails buying and holding positions, rather than actively trading them.
Step 2: Fund your account. The investor needs to fund their account once it has been approved and created. This can be done by ACH bank transfer, wire transfer, check, or by transfer from an existing investment account.
Step 3: Choose your stocks. Choosing dividend stocks or funds to invest in has become easier thanks to stock screeners available from most online brokers. The investor can use the screener to filter for dividend-paying stocks first, and you can also filter for a dividend yield above a certain rate.
The dividend yield of individual stocks should be compared to the level of interest rates, as well as the dividend yield of other stocks within the same industry or market sector. Once you have identified some good dividend-yielding stock candidates, determine the types of companies you want to invest in, such as the industry or sector. Other potential factors in choosing dividend stocks may include market capitalization, a company’s relative risk (using a stock’s Beta may be a helpful tool for this—see this article on how to use beta to calculate a stock’s risk), and the technical position of the stock using price charts and technical analysis with a larger focus on the medium and long term prospects for the stock.
Step 4: Monitor your stocks. Monitoring dividend stocks is similar to monitoring any other stock positions. You want to see the overall performance of the stocks, including how the various sectors and industries you have exposure to in your portfolio are doing. In addition to monitoring this overall exposure on the stocks’ overall performance, you should also look to see that dividends continue to be paid, and ideally that the dividends are increasing. Another part of monitoring dividend stocks is assessing the company’s ability to continue to pay dividends with company earnings, and not by using cash and other resources just to maintain the dividend. This analysis relates to the quality of earnings, the debt-to-equity ratio, and other fundamental analysis.
Step 5: Receive your dividends. Dividends on stocks are typically paid quarterly. There are four dates relating to dividend payments: the declaration date, the ex-dividend date, the record date, and the payable date. The declaration date states the amount of the dividend payment, as well as the ex-dividend and payable dates. The ex-dividend date is the first date of trading on the stock where the dividend will not be paid to the owner of the stock. The record date is the trading day after the ex-dividend date and represents the owners of the stock that will receive the dividend. Finally, the payable date is the day the dividend payment is actually made to stockholders.
What You Need to Open a Dividend Stock Account
Personal Information
Similar to other stock trading accounts, brokers require certain personal information to open a dividend stock account. This information includes name, Social Security number (or taxpayer ID number), address, email address, date of birth, and a government ID (such as a license or passport).
Financial Information
Brokers will also require personal financial information, such as net worth and income, under the Know Your Client (KYC) rules to determine whether opening a trading account is appropriate for you.
Opening a trading account for the purpose of wealth-building and obtaining income are conservative reasons to open an account, and are usually approved if the personal information is in proper order.
Compare Some Top Platforms for Investing in Dividend Stocks
| Company | Fees | Account Minimum |
|---|---|---|
| Fidelity | $0 for stock/ETF trades, $0 plus $0.65/contract for options trade | $0 |
| Interactive Brokers | $0.00 commissions for equities/ETFs available on IBKR’s TWS Lite, or low costs scaled by volume for active traders that want access to advanced functionality such as order routing.$0.65 per contract for options on TWS Lite; that is also the base rate for TWS Pro users, with scaled rates based on volume. $0.85 per contract for futures. | $0 |
Types of Dividend Investments
Dividend investment options include individual stocks, high-yield mutual funds and ETFs, and dividend-appreciation funds and ETFs. All of these investment types entail the purchase of dividend-paying stocks, but mutual funds and ETFs are investment vehicles that purchase multiple dividend stocks on behalf of their investors.
Individual Companies
Investing in individual companies that pay a dividend is the most direct way to gain access to dividend-paying stocks in a portfolio. In this instance, the investor creates a portfolio of different companies that pay a dividend by performing their own research and making their own decisions on which stocks to hold in their portfolio. This method does not typically involve any additional expenses, especially as most online brokers provide commission-free stock trading. The investor is responsible for all of the investment decisions, however, so must do their homework and continuously monitor their positions.
High-Yield Mutual Funds and ETFs
High-yield mutual funds and ETFs are managed funds that select high-yielding dividend stocks on behalf of their investors. With these funds, the investor does not have to choose the individual dividend stocks for their portfolio, but they still get the dividend payments in the form of cash or by reinvesting the dividends in additional shares of the mutual fund or ETF. While most of these funds pay dividends on a quarterly basis, some do so on a monthly schedule. There are fees associated with these funds, which impact the overall performance of these funds, so the investor will have to evaluate whether the fees are worth paying relative to overall performance and not having to choose and manage the dividend stocks they are investing in themselves.
Dividend-Appreciation Funds and ETFs
Dividend-appreciation funds and ETFs are similar to high-yield mutual funds and ETFs, but the dividend stocks the professional managers choose for these portfolios will consist of dividend stocks that have consistently increased their dividends over several quarters. Like high-yield mutual funds and ETFs, investors need to take the funds’ fees into consideration when choosing a fund.
Compare Some of the Top Dividend Stocks
| Company | Forward Dividend Yield | Payout Ratio |
|---|---|---|
| Frontline PLC (FRO) | 29% | 0% |
| Two Harbors Investment Corp (TWO) | 19% | 58% |
| 18% | 73% |
Factors to Consider When Opening a Dividend Stock Account
Fees: Fees are an important factor in any trading account, as fees impact the overall returns on an investment account. Fortunately for those trading individual dividend stocks, most brokers have moved to a commission-free model, so there is no cost. Commissions on individual stock trading are also very low for those trading in commission accounts, but most dividend investors are likely to choose a no-commission broker for purchasing individual dividend stocks.
Investors choosing to gain exposure to dividend stocks though mutual funds or ETFs should look at the fees and expense ratios charged by those funds, which will impact overall returns. Fees on ETFs are typically lower than on mutual funds.
Account minimums: The majority of online brokers no longer have account minimums, although some mutual fund companies have minimum investment amounts when investing directly through them. However, investors can gain access to many dividend mutual funds and ETFs directly through one of the many commission-free online brokers.
Research and trading tools: Research on dividend stocks is an important factor in deciding on which stocks to add to a portfolio, so it is helpful to use a broker that offers a good stock screener, as well as good fundamental and technical information for researching companies and industries.
As for trading tools, having the ability to use conditional orders to manage trading positions for profit and loss management, and the ability trade and monitor positions directly from a price chart, are nice-to-have features, but less critical since dividend investing typically involves more of a buy and hold, and much less active, trading style. This article explores the pros and cons of a passive buy and hold strategy.
Customer service: With any broker, good customer service is a nice thing to have. While choosing and investing in dividend stocks and funds is a pretty straightforward endeavor, those newer to investing may particularly benefit from responsive customer service that can help them learn how to use stock screeners, make decisions on automatic reinvestment options, and execute trades. Some brokers offer live chat services in addition to customer service by phone, and there is a difference between brokers on their response times.
Security: Account security, including features such as two-factor authentication, is important to ensure the safety of your trading account. In addition, while most brokers have Securities Investor Protection Company (SIPC) protection on accounts, some brokers offer additional account protection—typically through excess coverage beyond SIPC protection through Lloyd’s of London insurance policies backing the broker—that might be an important consideration for investors with accounts exceeding SIPC coverage limits.
FAQs
How Are Dividend Stocks Taxed?
Both qualified and unqualified dividends are included on a tax return, but they are treated differently for tax purposes. Ordinary dividends are the most common dividend paid by stocks and mutual funds that invest in stocks, and represent payments to the stockholder from a company’s earnings and profits. Ordinary dividends can be either qualified or unqualified. Unqualified dividends include dividends from regular dividend-paying stocks that are not held by the investor for a certain required holding period, as well as dividends from most real estate investment trusts (REITs), employee stock option plans, tax-exempt companies, and mutual funds that invest in fixed income products (including money market mutual funds). The holding period for a stock dividend to be a qualified dividend, for an otherwise qualifying stock, is 61 or more days out of the 121 day period that starts 60 days before the stock’s ex-dividend date (for preferred stocks, the holding period is 91 days out of the 181 day period starting 90 days before the ex-dividend date).
Unqualified dividends are taxed as ordinary income at the tax filer’s tax rate based on their overall income. Tax rates for qualified dividends are also based on the taxpayer’s income, but are lower, in line with capital gains tax rates, which are currently either 0%, 15%, or 20%. For 2023, the breakpoints on qualified dividends for an individual tax filer are 0% up to $41,675 in taxable income, then 15% to $459,750, then 20%. For those married and filing jointly, the breakpoints are 0% up to 83,350, then 15% to $517,200, then 20%, so there is a marriage penalty on qualified dividend taxation for those married and filing jointly if their combined income is more than $459,750.
Are Dividend Stocks the Same as Dividend Funds?
A dividend stock is an individual stock, while a dividend fund is a mutual fund or ETF that invests in multiple dividend-paying stocks. Investors in dividend funds can choose to reinvest dividends for more shares of the fund or ETF or simply take the dividends as an income stream. Holders of individual dividend stocks can take their dividends as an income stream or may have the option to participate in a Dividend Reinvestment Plan (DRIP) that automatically reinvests dividends for additional shares of the individual dividend-paying stock.
Are Dividend Stocks a Volatile Investment?
Like with any stock, dividend stocks are impacted by the overall rise and fall of the markets, making them vulnerable to periods of volatility. But as a whole, these stocks have a tendency to be less volatile than non-dividend stocks. In part, this is because investors in dividend stocks have a tendency to be buy-and-hold investors looking for passive income, rather than very active traders. Other criteria that can be helpful to screen for includes companies with strong cash flow, long-term earnings between 5% and 15%, and low debt-to-equity ratios.
Who Should Invest in Dividend Stocks?
Any investor looking to accumulate wealth over the long term should consider including dividend stocks as part of their overall portfolio. Investing in dividend stocks has long been adopted as a solid method for building wealth over long periods of time, and dividend investing will likely continue to be used for this purpose because it offers passive income and compounds over time, and also provides a hedge against inflation more effectively than bonds.
